Charitable contributions made in 2016 may provide a bigger benefit than in future years due to the possibility of a reduction in overall tax rates.
The value of the benefit of a deduction depends on the taxpayer’s tax bracket. For example, a taxpayer in the 25 percent tax bracket will receive a $250 tax benefit from a $1,000 tax deduction, whereas the same deduction by a taxpayer in the 35 percent tax bracket would reduce taxes by $350. The value of a deduction, therefore, decreases as tax rates decrease. Under President-elect Donald Trump’s tax plan, the highest individual tax rate would be reduced from 39.6 percent to 33 percent, a reduction of the tax benefit of almost 17 percent. If this or another proposal for tax rate reduction comes to pass next year, the benefit of a charitable contribution will be decreased in years after 2016.
Another reason to consider a charitable contribution this year is that the itemized deduction for charitable contributions may be reduced or eliminated next year. President-elect Trump’s proposal includes limiting itemized deductions to $200,000 for married couples filing joint returns. The current limit on charitable contributions allow taxpayers with significant income to make significant contributions, subject only to a limit equal to 50 percent of adjusted gross income for contributions to most charities, and 30 percent of adjusted gross income for contributions to private foundations. A taxpayer with an adjusted gross income of $1 million would be able to contribute $500,000 to most charities this year, but (under the proposed plan) would be limited to $200,000 for all deductions including charitable contributions, mortgage interest, real estate taxes, state and local income taxes and medical expenses. The limits under the Trump proposal would, therefore, significantly impair the ability of high income taxpayers to take advantage of the tax savings that incentivize charitable giving.
While many taxpayers might be reluctant to make a significant contribution this year and reduce or eliminate contributions in later years, one solution is a contribution to a donor advised fund. A donor advised fund is a separate account or fund that is maintained by a public charity. Often described as a “charitable savings account,” a donor advised fund allows a taxpayer to contribute cash or appreciated assets in the current year to receive a tax benefit in that year and then advise the fund on grants to be made to specific charities in later years.
While it is impossible to predict whether and when the proposed changes will occur, in light of these proposals, taxpayers who give to charity, particularly those who are considering substantial charitable contributions, should factor the possibility of these changes into their planning for contributions in 2016.